Week Ahead: Santa May Visit Wall Street After All

Stocks have a good chance of sailing higher into the end of the year on an old-fashioned Santa rally.

Richard Drew

Christmas on Wall Street

The S&P 500starts off the week Tuesday, slightly positive for 2011 after an 11 point gain Friday put it at 1265, eight points, or 0.6 percent, above last year’s closing level.

Stocks, in fact, come off their best four days since September, as traders shifted focus from negative European headlines to mostly positive U.S. economic reports.

“We’re beginning to see something of this Santa Clausish rally. This is what tends to happen now. We’re up six of the last seven days, not by all that much and historically this is the ‘Santa Claus’ period of time which extends into the New Year,” said Dan Greenhaus, chief global strategist at BTIG.

Trading desks are lightly staffed, and politicians on both sides of the Atlantic are now home for the holidays.

In the week ahead, there are just a few U.S. economic reports, including weekly jobless claims and Chicago purchasing managers on Thursday.

Traders will also be looking for any word on the outcome of the holiday shopping season.

They will also watch Chinese PMI, released Friday morning, for any signs that Chinese manufacturing could be slowing.

Italy auctions about 22 billion euros in bills and notes Wednesday and Thursday, and that will get a fair amount of attention, especially if yields continue to rise.

The Italian 10-year briefly rose above 7 percent again on Friday, a level investors see as unsustainable.

The Dow in the past week rose to 12,294, up 3.6 percent for the week, its highest level since July and its sixth best week of the year.

The dollar was basically flat, and the euro, while volatile, finished the week at 1.304, close to where it started.

The 10-year yield, after slumping to 1.796 percent earlier in the week, ended Friday just above 2 percent.

“We think month-end and quarter-end flows are going to be dollar negatives, so that could be supportive of a risk rebound,” said Brian Dolan of Forex.com.

“The start of the New Year should see some repositioning. A lot of people called it a year, back in October and are sitting on cash. Are they going to put it to work? Are they going to come out of the gate and buy risk assets?” Dolan said. “There is an argument they would, so I would not be surprised to see two to three weeks of gains at the beginning of the year.”

Bill Stone, chief investment strategist at PNC Wealth Management, says the last five days of the year and the first two of the new year are when the traditional “Santa rally” occurs.

Since 1969, there have been 31 positive returns during that time, for an average gain of 1.6 percent.

He said some of the notable misses were 1990, due to concerns about Operation Desert Storm; 1999, ahead of the tech bubble’s burst; 2004, due to the pending Iraq war and the tsunami in the Indian Ocean, and in 2007, the onset of the financial crisis.

When Santa doesn’t show, typically a bear market follows.

Analysts do expect the stock market to be challenged in 2012, but ultimately end the year with gains. Stocks could suffer as the economic fallout from Europe’s debt crisis hits corporate profits, and its sovereign crisis continues to hang over markets.

The U.S. presidential election could also start to become a bigger factor, and while the U.S. economy improved in the fourth quarter, many economists expect a slower first half before a pick up in the second half.

“Its’ safe to say volatility continues but the most important dominating factor will be uncertainty. It’s been here for several years, since 2007, so you’re talking five years of uncertainty. There’s been huge moves in bonds, commodities, stocks. They are all suffering from the same things,” Greenhaus said.

“There’s no reason to be more optimistic in January than you were in December because everything plaguing the market carries through into January,” he said.

While the S&P is close flat for the year, he notes the Dow is up more than 5 percent.

“When we talk about the third year of the presidential cycle being higher, we talk about the Dow, and not since 1939 has the Dow been down in the third year of a President’s term,” he said.

Greenhaus said while the indexes are not stellar, there have been some strong stock performers.

He pointed to MasterCard, up 68 percent for the year, Ross Stores, up more than 50 percent, and Humana, up 63 percent.

Paul LaRosa, chief market technician at Maxim Group, said the market is beginning to feel a bit better, with some individual stocks making nice moves and more speculative money coming into the market.

“I’m kind of feeling a little better here, like we could start setting ourselves up for a little run. Stocks here and there are up 5 percent on the day. There seems to be speculative money coming in for the day. There’s been some m and a activity. We’re cautiously optimistic, but I don’t think we’re set up for the great bull run everyone wants me to call for,” LaRosa said.

“This is the time of year people reposition their money a little bit. There could be some January affect stocks—stocks that have been beaten up, where people took some tax losses,” he said. “I’d rather be long than short, and still keep some cash…This becomes a preservation market, at certain points. It’s been buying on the dips.”

LaRosa likes pharmaceuticals, which are leading the market, but he also likes semiconductors and energy stocks, which are beginning to pick up.

Oil Drill

Oil made a big move this past week, as oil inventories came up short of expectations and geopolitical developments were a factor.

NYMEX oil , or West Texas Intermediate gained nearly 7 percent to $99.68 in the past week. Brent , a better measure for international crude prices, was at $107.96 per barrel, up more than 4 percent.

Violence in Iraq was one factor for the market.

Barclays analysts Friday pointed out that Iraq’s “fragile political equilibrium has seemingly begun to unravel with remarkable speed” after the withdrawal of U.S. troops.

They note that the consensus view is that Iraqi oil output is likely to fall fast, so therefore the back end of the Brent curve (future months future contracts) is starting to look underpriced at $90 per barrel.

Iran, another source of concern for energy markets, will hold naval exercises east of the Straits of Hormuz for 10 days, starting this weekend.